Articles
22 September 2017

GBP: A Florentine renaissance

PM May's speech has signalled a shift towards an ‘economically rational’ Brexit. This can only be good news for a significantly undervalued currency

Economically rational Brexit

Theresa May’s speech in Florence has signalled a shift in the UK’s position towards an ‘economically rational’ Brexit – one that seeks to reduce some of the medium-term UK economic uncertainty clouding sterling markets. This can only be good news for a significantly undervalued currency – though any upside potential may be less imminent and obvious at this stage.

While prospects of a two-year transitional period pose upside risks to our year-end GBP/USD and EUR/GBP forecasts of 1.33 and 0.90 respectively, we are reluctant to revise these until we see greater strides towards a deal. Michel Barnier’s response to the speech suggests this could be one of the focal points of Brexit talks over the coming weeks and months – and therefore we still retain a constructive GBP outlook in the near-term.

PM May’s speech fails to give mini-boost to GBP

The knee-jerk move lower in GBP suggests investors may have been hoping for a clearer and more succinct speech from the Prime Minister, rather than the one they got. In effect, it takes us to the same destination: the UK will be looking for a two-year status-quo transition deal with EU once the Article 50 period transpires in April 2019.

An agreed transitional period, in principle, could unlock further upside potential in the pound, but our economists wary that getting to that stage may not be a straightforward path. The response from the EU’s chief Brexit negotiator, Michel Barnier was fairly amicable, but he noted a transition deal is subject to “the wishes” of the EU. While they have previously supported the idea of a status-quo transitional arrangement, the finer details – such as the exact budgetary and judiciary conditions of any transition period – still need to be ironed out.

But a swiftly agreed transition could unlock GBP upside potential

If this two-year transition deal can be signed, sealed and delivered swiftly – then we see three channels which could make the GBP move higher:

(1) reinforced BoE policy tightening sentiment and a steeper UK rate curve

(2) a recovery in domestic investment prompting upside risks to the UK's growth outlook

(3) a reduction in GBP downside tail risks stemming from cliff-edge Brexit risks being pushed further down the road

Final word

A combination of these factors would inject some modest upside to pound over the coming months, with GBP/USD potentially moving up to 1.38-1.40 by year-end. Equally, we could see EUR/GBP trade in a slightly lower range of 0.85-0.87 on the basis of a swift transition deal.


Disclaimer

"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.

This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.

The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.

Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.

ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).